Summers critique of government debt and monetary policy

The latest buzz in macroeconomics is what I will call the Summers Critique of Debt and Monetary Policy. It can be found in Government Debt Management at the Zero Lower Bound from the Huchin Center at Brookings. The argument by Summers and his co-authors is simple. The Treasury has been issuing more debt and have extended its average maturity in order to take advantage of the low interest rates in the debt markets. Finance government at long-term at low rates. Of course, this new supply could force up interest rates. This is up for debate but depending on your view of yield curve and flow of fund dynamics. The Fed at the same time has been buying up long maturity debt in order to push down rates. The action of the Treasury could actually be offsetting some the work that has been done by the Fed to bring down long rates. It is an empirical question but there is a chance they are working at cross purposes.

The Treasury debate increase on the long end of the curve is about 70% from debt increases and 30% from lengthening outstanding debt. The Treasury has been managing debt without thinking about monetary policy and the Fed has been thinking about managing long rates without accounting for  debt management activity. Their independence is placing debt and monetary policies at odds.  These choices place the economy at risk because there is duration risk with financing options.

The Summers argument is that the Treasury should be financing with short rates where rates are zero instead of putting upward pressure on long rates. There may be a shortage of  the safe asset so borrow at the lowest financing costs now and worry about the future tomorrow. While the offset has not been one for one, the authors believe that the Treasury debt management has been a drag on Fed effectiveness. This management issue may become all the more important with the end of QE. The unwinding should be coordinated with the Treasury department.